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'Pump and Dump' Scheme

10th June, 2024

'Pump and Dump' Scheme

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In News

  • The Securities Exchange Board of India (SEBI) fined 11 individuals Rs 7.75 crore for a 'pump and dump' scheme in the scrip of Svarnim Trade Udyog.
  • Recommendations were shared via Telegram channels, leading to inflated stock prices and subsequent public losses.
  • In November 2022, SEBI announced plans to regulate financial influencers on social media.

Understanding the 'Pump and Dump' Scheme

Definition

  • A stock manipulation tactic where the price of a stock is artificially inflated through false information, leading to inflated prices followed by a sell-off, causing investor losses.

How It Works

  1. Acquisition: Large amounts of a low-priced, thinly traded stock (often micro-cap or penny stocks) are purchased.
  2. Promotion: The stock is aggressively promoted through mass emails, newsletters, and social media, creating a buzz and driving up demand.
  3. Price Inflation: Increased demand causes the stock price to rise sharply, creating the illusion of a high-potential investment.
  4. Sell-Off: The manipulators sell off their shares at the inflated prices, causing the stock price to crash and leaving other investors with significant losses.

Impact on Investors and the Market

  • Investor Losses: Those who bought at inflated prices face substantial financial losses.
  • Market Integrity: These schemes undermine market confidence and deter legitimate investors.
  • Legal Penalties: Participants can face severe penalties, including fines, profit disgorgement, and imprisonment.

SEBI Regulations and Actions

Regulatory Framework

  • Prohibition: Pump and dump schemes are completely banned under SEBI guidelines.
  • Recent Actions: SEBI ordered a crackdown on a YouTube-run pump-and-dump operation and is framing regulations for financial influencers.
  • Influencer Impact: Unqualified financial advice on social media has been problematic, with notable cases involving celebrities like Bollywood actor Arshad Warsi and his wife.

Investor Protection: Cautionary Measures

  • Avoid Unsolicited Offers: Be wary of investment offers from unknown sources, as these often indicate pump and dump schemes.
  • Research: Conduct thorough research before investing and avoid blindly following celebrities or promoters.
  • High Returns: Be skeptical of investments promising unusually high returns or those promoted through unsolicited means.

Regulatory Recommendations

  • Social Media Surveillance: Regulators should employ advanced social media monitoring to detect and prevent fraudulent schemes, protecting investors' hard-earned money.

Conclusion

  • Investors must remain vigilant and informed about the tactics used in pump and dump schemes. By exercising caution and conducting independent research, they can protect themselves from significant financial losses.
  • Regulatory bodies like SEBI are continually working to enhance protections and crack down on financial misconduct, ensuring market integrity.

PRACTICE QUESTION

Q. Which of the following best describes the term "Pump and Dump" in the context of the stock market?

A. A strategy where investors buy low-priced stocks and hold them for long-term gains.

B. A tactic where the price of a stock is artificially inflated through false information, leading to inflated prices followed by a sell-off, causing investor losses.

C. A method used by companies to issue additional shares to raise capital for business expansion.

D. A technique where traders short-sell stocks they expect to decline in value over a short period.

Answer:

B. A tactic where the price of a stock is artificially inflated through false information, leading to inflated prices followed by a sell-off, causing investor losses.